A closer look at future airline capacity in Vietnam (part 2)

Continuing from yesterday, I wanted to dive deeper into the potential capacity of the Vietnamese market. I will do that in a few steps. First, the potential for the market as a whole. Second, the airlines capacity and potential capacity. Then third, what the impact of new planes will be. The domestic Vietnamese market was almost 36 million passengers in 2018. That is up from 31.6 million in 2017. It is a duopoly with Vietjet holding a 45% share in 1H2018, Vietnam Airlines at 38%, JetStar Pacific at 15% and Wasco with the rest.

First, let’s estimate the potential of the market.

GROWTH HAS BEEN VERY FAST, BUT HOW MUCH LONGER SOURCE: CAPA

Growth has been quite fast, with a CAGR from 2011 to 2018 of 17.0%. International passenger growth has been even faster at 18.2%. The Vietnamese aviation administration expects the growth to continue at high levels – 13% annual growth into 2030 to reach 280m passengers. The International Air Transport Association (IATA) is more conservative, looking for just 4% annual growth to 2035 reaching 150 million passengers. The IATA forecast seems more reasonable to me – by 2035, most forecasts have the population rising to something like 110m. At 150m, that would mean that passengers are about 36% more than the population, or about the same ratio as we saw in Turkey in 2017 (108m passengers for a population of 81m). And just looking at absolute passenger figures, right now only the US and China (both richer and with larger populations) have more than 200m passengers at 849m and 551m, respectively. In fact, the UK and Ireland are the next largest at 150m each, and both are big hubs.

THAILAND’S EXPERIENCE MAKES US DOUBT THAT VIETNAM WILL REACH MORE THAN 200M PAX A YEAR SOURCE: WORLD BANK, WORLD ATLAS

But what really makes us think this is unlikely is that Thailand has nowhere near that many airline passengers. According to the World Bank, it had only 71m passengers for a population of 69m and 35m international visitors. The international visitors are more than 2x Vietnam, and the country is also richer than Vietnam (2.4x richer on a nominal 2016 GDP level). So that makes it unlikely that the country will reach more than 200m passengers, or even the 150m IATA is anticipating.

But, even if we take the 150m as the 2030 figure, and assume that growth is heavily front-loaded, by 2025 we could see total passengers carried at 100m, likely equally divided between domestic and international. If each plane in the domestic market carries an average of 400,000 passengers a year, we would need 125 planes. The same for the international market.

What would 125 planes in the domestic market mean for capacity?

CAPACITY ADDITIONS LIKELY TOO AGGRESSIVE SOURCE: VIETECON, COMPANY WEBSITES

VietJet currently has 63 planes but an order for 179 more, Bamboo wants to have around 45 planes or so, and AirAsia wants to expand to 30. Vietnam Airlines has a fleet of 87 with orders for another 28 [check – this is from Wikipedia]. It looks like Jetstar Pacific only has 8 planes in Vietnam, but I am going to assume they add 10 more (as a reasonable guess). That means if all orders went through, there would be 450 planes, which on average would have a passenger capacity of c450,000 a year. That would equate to 202m passengers a year, quite a number and well above the 100m passengers we see by 2025.

What conclusions can we draw?

First, the companies will likely have not be able to make all the orders that they want. This is especially true for VietJet, which has an enormous order book.

Second, it is very likely that there will be a price war in the next few years. I probably didn’t have to do the math to reach that conclusion, but having done the math, airlines will take any hiccup in passenger growth as a call to lower prices and attract more riders.

Third, lower prices will be very bad for profits. AirAsia is already losing money in most of its markets, and VietJet, while making money, has higher unit costs ($0.24 excluding jet fuel) than AirAsia ($0.19 as of 3Q2018).

In his 2007 Chairman’s letter, Warren Buffett wrote:

The worst sort of business is one that grows rapidly, requires significant capital to engender the growth, and then earns little or no money. Think airlines. Here a durable competitive advantage has proven elusive ever since the days of the Wright Brothers. Indeed, if a farsighted capitalist had been present at Kitty Hawk, he would have done his successors a huge favor by shooting Orville down.

Buffett famously changed his tune in 2017 by investing up to $10m in US carriers, mainly because he felt they were now more disciplined and only adding capacity justified by demand. Based on the current order book, I believe we could be looking at incipient overcapacity by the Vietnamese airlines (including AirAsia), despite the fast growth in passengers. If the companies order airlines as aggressively as they have publicized, we could very soon see overcapacity in the market. That would be good for passengers, but bad for the airlines’ profitability.

Update (Jan. 9, 2019): Bamboo Airlines announced that they have received their license from the Vietnamese government. You can read about it here.